Though
leadership of critical energy & infrastructure matters

Issue 173 – March 2018

From the
editor’s desk…

Welcome
to Pipes & Wires #173, which starts with a look at compensating battery
storage for grid support. We then look at 2 electricity distribution revenue
decisions and 1 rail revenue decision, and then we look at 3 larger mergers in
the US.

This
issue concludes with a look at the proposed end of wind power subsidies in the
US state of Oklahoma, and the key features of the next gas and electricity
price control in the UK. So … until next month, happy reading…

Recent client projects

Recent
client projects include…

·Developing a strategy for complying
with the related party transaction provisions.

·Advising on the regulatory implications
of an aging timber transmission pole fleet.

·Facilitating a series of client
workshops to better understand asset information criticality and in-service
failure risk.

How much and on what basis electricity
markets pay emerging technologies for the various electricity products they can
provide is a hot topic at the moment. After a quick recap on grid operations
and electricity products, this article examines recently introduced rules in
California that will inter alia allow
revenue stacking.

Grid operations and electricity products

Back in the vertically
integrated days, generators just supplied all the electricity products that
were necessary to keep the transmission grid working … peak capacity, frequency
keeping, voltage support, black start capability, rotational inertia … as well
as the most visible products of energy and reactive support. Vertical
disaggregation of the electricity industry meant that the grid had to buy these
products from generators using market based payment mechanisms. Some might say
this has been slow … perhaps too slow … to evolve, and in some cases has met
with considerable resistance by policy makers and regulators.

California’s energy stacking rules

In January 2018 the California
Public Utilities Commission approved rules that allows the operator of a distributed energy resource (DER)
to provide (“stack”) multiple electricity products that can each be paid for on
an incremental basis for the value that provide for individual components of
the electricity supply chain. The rules were considered necessary to overcome
the difficulties wherein DER’s could only be paid once even if they provide
multiple electricity products (note that the interim Rule 12 limits payment to
electricity products that are distinct, incremental and measurable).

The electricity distributor in
the Australian Capital Territory (Evoenergy) recently submitted its Regulatory
Proposal (rates
case) to the Australian Energy Regulator (AER) for the 5 year period commencing
on 1st July 2019. This article examines the key features of that
Proposal to set some context for examining the Draft and Final Determinations.

Pipes & Wires will revisit
this story when the AER releases its Draft Determination.

UK – the PR18 rail access price review

Introduction

The Office of Rail and Road (ORR) has begun work on the PR18 price review that will apply to Network Rail for the CP6 control period 1st April 2019 to 31st
March 2024. This article follows up from Pipes
& Wires #166 (which
examined the key features of the regulatory framework) with a quick look at
Network Rail’s CP6 Strategic Business Plans.

A bit about Network Rail

Network Rail is a
government-owned corporation that owns and operates 20,000 miles of railway
infrastructure throughout England, Wales and Scotland that is managed as 8
routes. That track infrastructure is provided on an open-access basis to
independent train
operating companies
(TOC’s). Network Rail’s regulatory and funding framework includes legislation,
statements of expectations from the English and Scottish governments, and grant
funding.

Pipes & Wires will comment
further once the AER releases its Draft Decision.

Mergers and acquisitions

US – examining the Dominion – SCANA merger

Introduction

It’s been a while since Pipes
& Wires examined any mergers, so let’s re-examine what’s been happening.
This article examines the merger between Dominion Energy and SCANA
Corp, and
then moves to a wider look at the recurring themes and trends.

A bit about Dominion

Dominion Energy is a vertically
integrated electricity and gas supplier based in Richmond, Virginia. It is huge
even by US standards … 27,000 MW of generation, 14,000 miles of gas
transmission pipelines, and 975 BCF of gas storage. Dominion supplies 2,500,000
electric customers in Virginia and North Carolina, along with 2,300,000 gas
customers in Idaho, Ohio, Utah, West Virginia and Wyoming.

A bit about SCANA

SCANA is an energy holding
company based in Cayce, South Carolina. SCANA supplies about 1,800,000 electric
and gas customers throughout South Carolina, North Carolina and Georgia, mainly
through its regulated subsidiary SCE&G. SCANA’s history dates back to 1846 when the Charleston
Gas Light Company was
established.

The merger

Dominion and SCANA announced
their all-stock merger in January 2018, in which SCANA shareholders will
receive 0.669 Dominion shares for each SCANA share. This would value SCANA at
$55.35 per share, with the total deal being worth $14.6b including debt. The
merged entity would operate about 31,400 MW of generation and supply about 6,500,000
electric and gas customers. Customer benefits of the merger include a $1.3b rebate
and a 5% tariff reduction.

In addition to the merger being
subject to the usual approval of state-based regulators, the FERC and the NRC, this merger will also receive close scrutiny from the South
Carolina Government due to the inclusion of the abandoned VC
Summer nuclear station.

The issue of the VC Summer nuclear station

The Virgil C. Summer nuclear
station was a joint venture between SCANA and the state-owned Santee-Cooper
electric company. In 2008 plans were announced to construct two AP1000 reactors adjacent to the existing reactor which began operation in 1984.
In July 2017 SCANA and Santee-Cooper abandoned the construction after spending
$9b when further studies revealed that the likely cost of completion would be
about $25b, more than double the originally budgeted $12b.

The whole saga is obviously
broad and deep, however the issue directly relevant to this article is the need
for SCANA to strengthen its financial position after writing down $1.7b.

Recurring themes in mergers

Over the years Pipes &
Wires has observed some concerning themes, with the following two being perhaps
the most concerning…

·Government agencies allowing a wider range of community bodies to
object to mergers, ostensibly allowing those bodies to extract special interest
concessions and dilute the merger benefits.

It’s possible that beneath the more
visible shadow of the VC Summer issue, these issues are also impacting the
Dominion – SCANA merger. Pipes & Wires will comment further as the various
regulatory approvals progress and legislative scrutiny of the VC Summer
abandonment continues.

US – NextEra Energy searches for regulated earnings

Introduction

As a follow on from the
companion article that discussed the troubled Virgil C. Summer nuclear station
and its 45% owner Santee-Cooper, this article examines NextEra Energy’s possible bid for Santee-Cooper as part of its strategy to reduce
the risk exposure from its merchant generation business.

NextEra’s strategy

NextEra Energy operates 45,900
MW of generation in Canada and in 27 of the US states, but is perhaps more
visibly known through its subsidiaries Florida Power & Light and Lone Star Transmission. Annual revenues are about $16b, and it is the largest electric
company in the US by market capitalisation.

A large part of NextEra’s
strategy has been investment in low emission generation (wind, solar, gas and
nuclear complemented by transmission lines to deliver renewable energy)
balanced against regulated earnings from FPL&L which itself is driven by
Florida’s growing population. Although NextEra’s dividend yields are below the
utilities industry average, the growth of those dividends over the last 5 years
has exceeded the industry average growth.

However NextEra has identified
the need to reduce the risk exposure from its merchant generation businesses by
investing in regulated electric businesses, which is where Santee-Cooper comes
in.

A bit about Santee-Cooper

Santee-Cooper had its origins
in the 1930’s as both a rural electrification project and a public works program,
and now supplies about 165,000 residential customers as well as bulk supply to a
further 1,500,000 customers of South Carolina’s electric cooperatives.
Santee-Cooper’s directors are appointed by the Governor and ratified by the
South Carolina Senate.

The decision to abandon
construction of the two AP1000 reactors at the Virgil
C. Summer nuclear station (of
which Santee Cooper was a 45% owner) has left Santee-Cooper with an extra $4b
of debt. A key outstanding issue is how much of the sunk costs can be recovered
by SCANA’s subsidiary South Carolina Electric & Gas through its regulated
tariffs.

Further news emerged in
mid-March 2018 that the Central Electric Power Cooperative is suing Santee
Cooper on behalf of 20 of South Carolina’s electric coops to prevent it
recovering more of the $9b VC Summer nuclear expansion costs from the coops,
and to receive 70% of Santee-Cooper’s settlement with Westinghouse.

Possible bid for Santee-Cooper

It is understood that Duke Energy, Southern
Co and Dominion Energy have shown interest in Santee-Cooper, but the most serious offer
appears to be from NextEra which is offering a deal estimated to be worth $15.9b
over 30 years. This deal would freeze tariffs for 5 years and pay down part of
Santee-Cooper’s debt. Not surprisingly the deal process is intensely political,
with an obvious concern being Santee-Cooper’s transition from a cooperative
model to an investor-owned model with the associated increase in cost of
capital.

Pipes & Wires will examine
this issue further as NextEra’s offer unfolds, and also as the South Carolina Public Service Commission determines how much of the sunk costs of the two additional
reactors can be recovered from customers.

Great
Plains and Westar filed their merger proposal with the KCC in August 2017. Key
features of that proposal include…

·The formation of a yet-to-be-named
corporation that would be 52.5% owned by Westar shareholders and 47.5% owned by
Great Plains shareholders, and which would have an equity value of about $14b.

·A one-off $50m credit spread across all
customers.

·The retention of Westar’s Topeka head
office and its 500 staff for at least 5 years, including a requirement for no
involuntary lay-offs.

Both
companies reiterate their original justification of improving scale and
avoiding increasing costs per customer as the reason for pursuing the merger,
and believe that the merger addresses all the concerns that led to the KCC
rejected the previous acquisition proposal.

Progress on the merger

The following progress on the
merger has occurred…

·In November 2017 over 90% of shareholders voted to approve the
merger.

·A public hearing in mid-January 2018 in Topeka, Kansas was rather
quiet, with 3 people speaking against the merger and 3 speaking for it.

·The KCC released a staff report in late January 2018 recommended
approving the merger subject to allocating more of the merger benefits to customer
through bill credits, a 5 year freeze on prices, and submitting an annual
earnings review to the KCC.

Pipes & Wires will comment
further when the KCC releases its final decision in June 2018.

Energy mix & emissions reduction

US – further pressure on wind subsidies
in Oklahoma

Introduction

Pipes & Wires #163 examined the curtailing of Oklahoma’s
zero emission tax credit on 1st July 2017. This article revisits
that issue to examine further moves.

Not
surprisingly, the push to phase out wind subsidies is being driven largely by
pressure on the State budget, which saw the cost of the wind subsidy grow to
$113m in 2014.

The various viewpoints

The
various viewpoints include…

·Supporters claim that the State is
reneging on previous commitments, and question why oil and gas subsidies
continue.

·Opponents of the wind subsidies claim
that subsidies are no longer necessary because the wind sector has successfully
attracted about $12b of private investment since 2004.

The editor comments

Notwithstanding
that most if not all special interest groups protest if their funding comes
under threat, wind energy and its subsidies (like solar) seem to be an
ideological issue in which the 2 main interest groups are miles apart with no
obvious middle ground. Perhaps the best we can hope for is an unhealthy
imposition of the ruling party’s wishes…

The
RIIO (Revenue = Incentives + Innovation + Outputs) regulatory model is the
output focused approach to regulating the UK’s electricity and gas networks
that replaced the prescriptive RPI – X model back in 2013. The current RIIO – 1
controls are in place for the gas distribution networks, the electricity
transmission networks and the gas transmission networks for the period 1st
April 2013 to 31st March 2021 (the RIIO – 1 control for the
electricity networks covers the period 1st April 2015 to 31st
March 2023).

Key features of RIIO -2

Key
features of RIIO – 2 include…

·Giving customers a stronger voice in
the revenue setting process though a test and challenge process.

·Incentives for electric companies to
respond to strategic changes, but with controls to limit customers risk
exposure should the future turn out differently.

·Clarifying and simplifying the way that
outputs, incentives and cost allowances are specified.

·Encouraging electric companies to think
smarter, with a big emphasis on competitive provision of emerging services by
third parties.

·The view that electric companies face a
low risk because of the stable and predictable regulatory regime.

·Additional rewards for electric
companies that deliver great service at low cost.

·Further downward pressure on returns,
including greater protection for customers from companies than earn higher than
expected returns.

On
the whole, RIIO – 2 doesn’t seem to hold much good news for electric companies
or their shareholders.

Next steps

Ofgem
will receive submissions on the RIIO – 2 framework consultation until 2nd
May 2018.

General stuff

Guide to NZ electricity laws

I’ve
compiled a “wall chart” setting out the relationship between various past and
present electricity Acts, Regulations, Codes etc in
sort of a chronological progression. To request your free copy, pick here. It looks really cool printed in color
as an A2 or A1 size.

A bit of light-hearted humor

What
if price control had been around in the 1920’s and 1930’s ?
A collection of classic historical photo’s with humorous captions looks at some
of the salient features of price control. Pick here to download.

Wanted – old electricity history books

Now
that I seem to have scrounged pretty much every book on the history of
electricity in New Zealand, I’m keen to obtain historical book, journals and
pamphlets from other countries. So if anyone has any unwanted documents, please
email me.

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Disclaimer

These articles
are of a general nature and are not intended as specific legal, consulting or
investment advice, and are correct at the time of writing. In particular Pipes
& Wires may make forward looking or speculative statements, projections or
estimates of such matters as industry structural changes, merger outcomes or
regulatory determinations. These articles also summarise lengthy documents, and it is important that
readers refer to those documents in forming opinions or taking action.

Utility
Consultants Ltd accepts no liability for action or inaction based on the
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